Latin America’s position in global leverage
Although the U.S. financial and household sectors have deleveraged after the 2008 crisis, overall global leverage has increased. One interesting corner of this story is the rise in Latin American issuance of international corporate debt. Latin America’s share of global issuance has been surprisingly substantial, and this increased leverage also bears risk. Yet, might LatAm companies have already mitigated these risks?
The growth in LatAm international corporate debt (issued in foreign currency, or FX) is a result of greater financial integration, low interest rates, and low term premia. Financial integration has meant greater access to international capital markets. Being able to borrow in FX, particularly the dollar, has enabled LatAm corporations to take advantage of low rates and thereby make more long-term investments such as capital expenditures.
At the same time, this increased exposure to the dollar, which is experiencing an extended period of strength, raises the cost of dollar-denominated liabilities relative to assets. It also increases interest rate risk: Should U.S. monetary policy tighten, borrowing costs would climb. Further, it could damage companies’ creditworthiness. These risks could spill over into the domestic banks that house LatAm corporate deposits, the global banks and asset managers that have invested in LatAm corporate debt, and the real economy.
Countries have reserves for dealing with these situations, but how prepared are companies? Corporations can mitigate these risks in a couple of ways: They can ensure that their FX liabilities are naturally hedged by matching their FX asset returns and revenue, or they can use financial derivatives to hedge FX exposure. Since exact firm-level hedging data are not available, issuer-sector exposure and volume of derivative transactions can serve as proxy indicators.
As it turns out, the largest issuers are companies in financially integrated commodity producing nations such as Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. Their private sectors issue the most debt and have the greatest foreign liabilities. They also have a higher proportion of commodities and energy exporters. Such firms are more accustomed to dealing with FX risk and are therefore more likely to have partially matched their FX assets and liabilities.
Furthermore, the volume of FX and interest rate derivatives transactions has increased in Latin America. Among Brazil, Chile, Colombia, Mexico, and Peru, transactional turnover rose between 2007 and 2013, from $28 billion to $67 billion for OTC FX derivatives and from $3 billion to $6 billion for OTC interest rate derivatives.
Overseas borrowing and leverage pose risk to financial stability all over the world. However, there are indications that indebted LatAm corporates, especially those in the sectors and countries that are most vulnerable, are a little less vulnerable than they might appear.
1. Other groups include non-financially integrated commodity exporters, which consist of Argentina, Bolivia, Ecuador, Paraguay, and Venezuela; and commodity importers, which include Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Jamaica, Nicaragua, and Panama.